On Oct. 12, 2022, the United States Court of Appeals for the Second Circuit denied a request for rehearing from a group of Revlon, Inc., lenders seeking to overturn the Second Circuit’s unanimous decision, issued on Sept. 8, 2022, requiring this syndicate group of Revlon lenders to return $500 million in funds mistakenly wired to them by Citibank, N.A.

That mistake–described by U.S. District Judge Jesse Furman of the Southern District of New York as “one of the biggest blunders in banking history”–took place in August 2020 when Citibank, acting as administrative agent on a $1.8 billion syndicated seven-year-term loan, inadvertently wired nearly $1 billion of its own funds, including the full amount of Revlon’s outstanding principal balance instead of the $7.8 million accrued interest payment it had intended to transfer, to a group of participating lenders. At the time, the loan was not due to mature for another three years.
 
Although Citibank promptly notified the creditors of its mistake the next day and demanded a return of the portion of the payment that represented the outstanding principal balance, it was only able to recover approximately $385 million from those lenders who agreed to return the funds. Citibank commenced an action for restitution in the United States District Court for the Southern District of New York to recover the remaining $500 million from the recalcitrant syndicate lenders who refused to do so. The lenders, as part of their defense, alleged that they not only believed the erroneous payment was intentional because each was paid precisely the amount of principal and accrued interest that each was respectively owed but that they otherwise would have had no reason to believe that Citibank, one of the most sophisticated financial institutions in the world, would ever make a mistake of such magnitude.
 
New York State common law generally provides that payments that have been mistakenly issued must be returned. However, one exception to this requirement is known as the “discharge-for-value” doctrine, which provides that a creditor does not have to return mistakenly paid funds that discharged a debt owed to them if it is established that the creditor: (i) is entitled to the funds, (ii) has no knowledge that the payment was issued erroneously, and (iii) made no misrepresentation to the debtor that it was required to make the payment.

In February 2021, following a trial, the Southern District of New York issued a 100-page decision, ruling in favor of the lenders. In relying on New York’s discharge-for-value doctrine, the Southern District of New York found that the lenders satisfied each of the “discharge-for-value” exception requirements, thereby entitling them to keep the mistakenly issued funds. As part of its finding, the District Court determined that the syndicate lenders were not required to return the mistakenly issued funds because such funds could be used to satisfy the debt owed to them even though the wired funds were not intended for that purpose. Citibank appealed the Southern District of New York’s decision to the United States Court of Appeals for the Second Circuit.
 
The District Court’s February 2021 decision on Citibank’s 2020 blunder sent loan agents scurrying to amend existing loan agreements to include “erroneous payment” provisions in an effort to provide administrative agents with a contractual right to seek a return of erroneously made payments.

However, on Sept. 8, 2022, the Second Circuit reversed the District Court’s 2021 decision, finding that all of the requirements necessary to invoke the discharge-for-value exception were not met. The Second Circuit held, inter alia, that the participating lenders were not presently entitled to the funds, whether by virtue of loan maturity (which was not due and payable for another three years) or acceleration of the debt upon an event of default by Revlon.
 
Moreover, although the syndicate lenders did not have actual knowledge that Citibank’s payment was erroneous, the Second Circuit nevertheless determined that certain facts (which were previously established at the District Court trial) put the lenders on inquiry notice that the payment was a possible mistake, thereby creating an obligation by the lenders to further inquire of Citibank. Specifically, the Second Circuit found that the lenders “were aware of four red warning flags consisting of facts suggestive of accident or mistake” that would have put any reasonably prudent investor on notice, including:

(i) “the absence of prior notice of a prepayment, to which the Lenders were contractually entitled”;
(ii) “the apparent inability of the insolvent Revlon to make a near $1 billion repayment”;
(iii) “in view of the fact that the 2016 Loan was trading at 20-30 cents on the dollar, it could have been retired far more cheaply than by paying its full value”; and
(iv) “Revlon’s elaborate contrivance only four days earlier to avoid acceleration of the 2016 Loan made no sense if Revlon was planning to retire that debt a few days later.”
 
As part of its analysis, the Second Circuit reasoned that the lender’s subjective good faith belief that the payment was intended is immaterial, but inquiry notice is instead subject to an objective standard–i.e., whether a reasonably prudent person would have made an inquiry of Citibank about the appropriateness of the payment in light of the red flags.

The Second Circuit was ultimately guided by equity in making its final ruling, stating that the “[a]pplication of the discharge-for-value rule to our facts brings the Lenders a huge windfall over and above what they bargained for, while an order of restitution would leave them exactly where they contracted to be.” As further echoed by one of the concurring Second Circuit judges, the Honorable Michael H. Park, a ruling in favor of the lenders would otherwise “turn equity on its head and topple the settled expectations of participants in the multi-trillion-dollar corporate-debt market” and be “brutally unfair.”
 
While the Citibank events have led to the inclusion of preventative language in loan documentation across the lending industry, the Second Circuit’s reversal of the District Court’s decision and ultimate ruling in favor of Citibank should not deem such language unnecessary. In fact, notwithstanding the Second Circuit’s holding, erroneous payment language should continue to be included as boilerplate provisions in syndicated loan transactions, as other jurisdictions may differ in their analyses depending on the specific facts at bar.